Most 401(k) plans offer a number of investment options for your money. A typical plan may offer six-to-eight options, but some offer an even broader range. If the plan allows you to direct the investments in your account, it's up to you to decide how to divide your money among the available 401(k) investment options. The choices you make may have a tremendous impact on the ultimate value of your 401(k), so it just makes good sense to educate yourself about the potential risks and rewards of each type of financial vehicle available to you. You may put your money in just one option or you may divide your contributions among various 401(k) investment options — some with higher risk and some with lower risk. Among the possibilities that may be available to you are the following 401(k) investment options:
Stable Value Funds
These funds are designed to provide consistent, predictable growth over the long term. Sometimes called the "Fixed Fund" or "Guaranteed Fund," these funds are typically backed by contracts issued by insurance companies, such as "Guaranteed Interest Contracts" or "GICs." This option is generally considered lower risk and is guaranteed by the issuing insurance company, but fixed interest rates and rising inflation can erode its earning power. Be sure to check the financial health of the companies issuing the GICs and other contracts. Firms such as Moody's, A.M. Best or Standard & Poor's issue financial ratings of insurance companies.
Company Stock
By selecting your employer's stock, you acquire an ownership interest in the company. Buying the stock of any single company — including your employer, however, carries a very high degree of risk and generally should represent only a small portion of your investment portfolio.
Mutual Funds
These options pool money from many investors and can invest it in various securities such as stocks, bonds and money market instruments. They are designed to help reduce (but not eliminate) risk. If you further diversify by purchasing shares in more than one mutual fund option, your risk may be reduced even more. Among the types of accounts that may be available to you in your 401(k) investment options are:
Money market mutual funds assets typically consist of U.S. Treasury bills, Certificates of Deposit (CDs) and other commercial investments. You'll find them on the lowest rung of the risk ladder. On the other hand, they also offer the lowest potential for return and may not beat inflation. An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the money market funds seek to preserve the value of the investment at $1.00 per share, it is possible to lose money by investing in a money market fund.
Bond mutual funds typically invest in government or corporate bonds, or a combination of both. Government bond mutual funds can invest in U.S. Government, state government, or local government bonds. Corporate bond mutual funds invest in a variety of bonds from companies across the country or around the world.
Bond mutual funds are subject to the performance of the bonds in their portfolio, and risk varies according to investment strategy. Generally, funds holding bonds with longer average-maturity periods have higher yield potential and higher risk. Bond mutual funds with a shorter average maturity are generally lower risk investments. Overall, bond mutual funds are low- to moderate-risk investments, with a few categorized on the high-risk side. Independent agencies such as Standard & Poor's and Moody's rate bonds in the marketplace according to risk.
Stock mutual funds are usually invested in various publicly traded stocks. A stock mutual fund’s value can rise or fall quickly over the short term. While past performance is not a guarantee of future results, historically stocks have performed better over the long term than other types of investments (e.g., government bonds, treasury securities). Stock prices fluctuate for a wide range of reasons, and stock mutual funds are subject to the same market risk as stocks. Not all stock mutual funds are the same or have the same level of risk. Most stock mutual funds fall into one or more of the following categories:
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Index mutual funds attempt to mirror the performance of stock market indexes, such as the Dow Jones Industrial Average or the Standard & Poor's 500 Composite Stock Price Index (S&P 500). They do this by investing in all (or a representative sample) of the companies included in the index. Investing in an index mutual fund reduces the risk that the fund portfolio will be subject to poor investment decisions. The downside to these mutual funds is that they're managed for average performance, so they rarely perform significantly better than the market in general.
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Growth mutual funds invest in companies that have better-than-average growth potential over time. The earnings of these companies, and therefore their stock values, are expected to increase. Growth mutual fund investments span a broad range of industries, and may or may not pay dividends.
Growth funds are considered higher risk, so expect significant fluctuation in share price.
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Income mutual funds invest in stocks that have a history of paying regular dividends. These investments tend to fall in the middle of the risk spectrum for stock mutual funds.
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Growth and income mutual funds generally invest in companies believed to have growth potential and a solid dividend payment record. They're designed to help you hedge your bets — even if the share price falls, dividends may offset the loss. Growth and income fall in the middle of the risk spectrum for stock mutual funds.
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Aggressive Growth mutual fund portfolios include stocks of start-up companies, smaller businesses or firms in high-risk industries. These stocks may be volatile and should be purchased by those with a higher risk tolerance.
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International mutual funds generally invest in stocks or bonds of non-U.S. issuers. Investors in these funds are taking on a high degree of risk, since the portfolios could be affected by political unrest or currency fluctuations in a foreign country. Often, international mutual funds invest in companies from emerging markets where business is rapidly developing (e.g., Latin America). The potential risks and rewards are very high.
Balanced Funds (Life Style Funds or Asset Allocation Funds)
Blending both stocks and bonds, these funds allow diversification with potentially lower risk than pure stock funds, but also with a lower potential for return.